Amnesia dooms Wall Street regulation

As numerous debates rage on about many of the arcane elements in the Dodd-Frank Wall Street Reform Act, it seems to me we have lost track of what it was supposed to do.

The real question should be whether its implementation has dealt effectively with the three major causes of the financial meltdown of 2008-2009.

By any objective standard, I believe the answer is no. Let’s look at those causes one by one.

The first thing virtually everyone agreed on back in those dark days was that American taxpayers had to be guaranteed that they would never again have to bail out a bank because it was Too Big To Fail. Democrat or Republican, we all wanted to be protected from TBTF institutions. So what’s happened?

In part because of the forced mergers in 2008 involving institutions such as Merrill Lynch, Wachovia, Washington Mutual and others, our biggest banks are bigger than ever.

Last week, the Federal Reserve announced that four U.S. banks, including the third-largest, Citigroup, failed stress tests designed to show whether they could withstand a financial shock.

No one can realistically claim that we could allow Citigroup or any of our top banks to fail today without risking an economic Armageddon.

Second, we know that the risky investments banks engaged in for their own accounts turned toxic and would have brought them down had there not been a bailout. Freed in 1999 from the constraints of the Glass-Steagall Act, they had and still have a no-lose situation. They make a lot of money when they make good investments, and since their assets are federally insured, they don’t lose when those investments go bad.

The taxpayer picks up the bill. The only thing left in the bill to deal with this, when Dodd-Frank was finally passed, was the Volcker Amendment to eliminate proprietary trading by banks.

As I write this, the Volcker Amendment is on life support. Over 90 percent of the people meeting with the Securities Exchange Commission about how it will be implemented represent Wall Street interests that are opposed to doing anything.

Finally, to prevent future meltdowns, we have to bring derivatives trading into the sunlight and make it more transparent.

This is not a new battle. Brooksley Born, then head of the Commodities Future Trading Commission, first raised awareness of over-the-counter derivatives in 1998, when Long Term Capital Management collapsed. She discovered that, unbeknownst to any regulators, LTCM had leveraged $4 billion into an investment of over $1.5 trillion in OTC derivatives. Her efforts to bring derivatives under regulation were frustrated. After she left the commission, Congress, with support from the Clinton administration, passed the Commodity Futures Modernization Act of 2000. CFMA deregulated derivatives entirely, actually banning any agency from regulating them.

As they say, the rest is history. The derivatives market exploded in the middle of the housing crash. You would think there would be general agreement that some kind of regulation is now necessary, but a lot of powerful forces are fighting against it.

A recent survey by Grant Thornton revealed that among corporations in the energy industry, “nearly two-thirds have not begun to implement the documentation and reporting of derivatives required by the law.”

House Agriculture Committee Chairman Frank Lucas, R-Okla., is fighting implementation because he says “it will put a heavy burden on the economy, specifically on non-swap dealing end-users in the agriculture markets.”

We didn’t learn from LTCM and we do not seem to have learned from the meltdown that followed.

During the debate on Dodd-Frank, I made the constant argument that we must make the hard choices right away, while the pain of the financial meltdown was still fresh. One of those who argued to the contrary, that the decisions should be left to the regulators, was Secretary of the Treasury Timothy Geithner.

It was therefore ironically interesting to read his comments in a recent column in The Wall Street Journal. “We cannot afford to forget the lessons of the crisis and the damage it caused to millions of Americans,” he said. “Amnesia is what causes financial crises.”

I wish he had been worried about financial amnesia two years ago. I am afraid that, at this point, the battle to correct the causes of the meltdown is just about over. And we have lost.

Originally published 17 March 2012 on